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Implications of El Salvador’s tryst with Bitcoin

There is no doubt that El Salvador and its President Nayib Bukele have created a stir in the world of money. With El Salvador entering the Bitcoin field, will we see other economies joining the fray?

June 15, 2021 / 09:08 AM IST
Bitcoin | Image: Shutterstock

Bitcoin | Image: Shutterstock

The Bahamas and El Salvador became unlikely winners of two important races concerning digital money. While The Bahamas became the first country to issue a central bank digital currency (CBDC), El Salvador became the first to permit Bitcoin as legal tender.

Legal tender means one can freely make payments in Bitcoin and more importantly the receiver cannot refuse payments in Bitcoin. While the race for the CBDC has been on for a while now, there was no such race for Bitcoin. In many ways, the race to make Bitcoin legal tender had huge potential, but it remained an empty field. With El Salvador becoming the first to enter the race track, how should we see this policy?

Before getting into the details, a bit of background is needed.

Bitcoin is a peer-to-peer payment system envisaged by Satoshi Nakamoto in 2008 just after the Lehman Brothers crisis. The idea was to create a separate currency and payment system using cryptography without the need for a central bank and banking system. The idea led to a wave of private cryptocurrencies which became more like crypto assets and stopped serving functions of a currency. As a result, the central banks mostly ignored these trends.

The game changed in 2018 with the advent of Facebook-backed Libra, which was designed as a stable currency. This pushed central banks to explore working on their own CBDC, with The Bahamas winning the race naming its digital currency ‘Sand Dollar’ — a digital representation of the Bahamian Dollar.

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In this regard, El Salvador’s experiment is really interesting. Whereas others are experimenting with CBDCs, El Salvador has allowed privately issued Bitcoin to circulate along with US Dollar (USD), the country’s currency. In 2001, El Salvador adopted the USD as its official currency along with Salvadoran Colon named after Christopher Columbus who was called Cristobal Colon in Spanish. If economies have high inflation, one option is to adopt stable currencies such as USD by which one also ends up having inflation similar to the US. We see this in the figures. In 1980-2000, average inflation in El Salvador was 14 percent, compared to 4 percent for the US. In 2001-20, the average inflation for El Salvador was 2.27 percent, almost equal to the US average of 2.06 percent.

Given the low inflation numbers, it is interesting that El Salvador has decided to give legal tender status to Bitcoin. We have generally seen people on their own adopting Bitcoin in hyperinflation countries such as Venezuela and Zimbabwe.

What is also interesting is how quickly this decision was taken. On June 5, El Salvador President Nayib Bukele tweeted about the benefits of Bitcoin in the area of financial inclusion. He proposed making Bitcoin legal tender by sending the draft Bill to the Congress. On June 8, the Bill was approved, paving roads for making Bitcoin a legal tender in the country in three months. That was quick! Compare this to India where there has been lot of uncertainty on policy regarding cryptocurrency.

How do we see this decision panning out in the world of money?

First, the idea of Bitcoin was so far used by libertarians who detested the State and its role in all things including money. In an interesting set of ironic twists, one such State not just approved Bitcoin but it was done by Bukele who is seen as an autocrat!

Bukele is guilty of sending soldiers into Parliament to intimidate legislators who were opposing him on a policy matter. He is young and has positioned himself as an innovator. He changed his Twitter profile picture after the Bitcoin announcement with blue light emitting from the eyes leading experts from the country calling this a mere publicity stunt. The International Monetary Fund (IMF) which has been helping El Salvador financially has reacted by saying adopting Bitcoin as legal tender has macroeconomic consequences and the IMF will be keenly watching the developments.

Second, it is one thing to declare something as legal tender and completely another to make it acceptable across the country. Given Bitcoin’s volatility, people are more likely to keep it as an asset rather than spend it for general purposes. Having said that, few shops were accepting Bitcoin even before this law. The exchange ratio between the USD and Bitcoin in the country will also be keenly watched.

Third, even when we consider first and second points, this is a small victory for Bitcoin supporters. Very few people, including ardent crypto supporters, expected to see this day this soon. Cryptocurrencies including Bitcoin have been under pressure of late with huge volatility and complaints over them being used mainly for money laundering and trafficking purposes. Given these circumstances, it is quite something to see a country declaring Bitcoin as legal tender.

There is no doubt that El Salvador and Bukele have created a stir in the world of money. Few imagined that of all countries, a small New Zealand would end up pioneering inflation targeting. A similar kind of development has happened in the case of El Salvador as well. One question occupying many of us will be that with El Salvador entering the Bitcoin field, will we see other economies joining the fray? Or will this just be a publicity stunt and peter out like several stunts of policymakers? Economists will be keenly watching these developments.
Amol Agrawal is faculty at Ahmedabad University. Views are personal.
first published: Jun 14, 2021 11:42 am

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